Samsung sees another profit dip, cites weak demand

SEOUL-- Samsung Electronics Co.'s warning of a third-straight quarter of profit decline highlights the pitfalls of the South Korean technology giant's reliance on smartphone sales.

While strong smartphone sales have propelled the company's growth over the last two and a half years, the reliance on them is a double-edged sword. When sales are good, the benefits trickle down to its other businesses, including components.

But Samsung said Tuesday that its operating earnings in the latest quarter likely fell by 22.3%-26.5% from a year earlier, hit by a glut of unsold smartphones, which also hurt the performance of the businesses that make microprocessors and displays used in its mobile devices.

In the first quarter of the year, Samsung's mobile unit accounted for about 76% of company profit, compared with just 25% for the same quarter four years ago when Samsung derived the bulk of its earnings from the sale of semiconductors.

Though Samsung forecast better results in the traditionally strong third quarter, the company, the world's biggest maker of TVs, mobile phones and memory chips, isn't likely going to be able to snap its quarterly string of declines anytime soon, analysts say.

That is because smartphone penetration in developed markets is nearing saturation. In emerging markets, Samsung is facing stiff price competition from Asian handset makers including Xiaomi Inc. and Lenovo Group Ltd.

Samsung said in an unusual explanatory note accompanying its profit forecast that in the second quarter, the company had to boost marketing to unload older and lower-end smartphones. In China, where consumers are waiting for the rollout of next-generation 4G LTE networks, Samsung suffered from a pileup of older 3G phones.

In addition, the company said that its sales of tablets were hit by the success of its own smartphone-tablet hybrids, dubbed phablets.

The company's admitted trouble in managing its inventory highlights the flip side of the company's vaunted reach into more than 100 markets: It is difficult to accurately gauge demand among fickle consumers in a fast-moving industry like the smartphone business.

Another major risk is the fluctuations in the foreign-exchange market, which have pushed the South Korean won to six-year highs. In the past year, the won has gained 13% against the U.S. dollar, a trend that traders expect to continue in the longer term--bad news to a Korean company that relies on exports for a major part of its revenue.

Even though there are high expectations for new product launches in the second half, including its flagship large-screen Galaxy Note device, Samsung's main rival in the high-end market, Apple Inc., is expected to launch bigger screen iPhones, according to people familiar with the matter.

"Samsung's earnings may bottom out in the second quarter, but the expected launch of iPhone 6 models will be a huge challenge for the company's high-end models in the second half," said Lee Seung-woo, an analyst with IBK Securities in Seoul.

Nomura analyst C.W. Chung said that given the increased pressure from rivals, and the difficulty of differentiating its products, Samsung would likely see the operating profit margin at its mobile unit, which was 19.8% in the first quarter, whittled down over the next few years, perhaps faster than the market had previously thought.

"In terms of the big picture, investors have already decided" that Samsung will struggle to differentiate itself, Mr. Chung said. "The big trend will be a downward trend."

This week, brokerage I'M Investment & Securities Co. cut its recommendation on Samsung to "hold," arguing the company will likely continue losing market share to Chinese brands, while sales of its flagship Galaxy S5 smartphone are expected to quickly lose momentum.

Samsung said Tuesday that its second-quarter operating profit likely fell to between 7.0 trillion won ($6.9 billion) and 7.4 trillion won from 9.53 trillion won a year earlier.

Tuesday's disappointing forecast followed a 3.3% decline in operating profit in the first quarter compared with a year ago, and marked its first decline by a double-digit percentage since the third quarter of 2011.

Investors had been bracing for Tuesday's weak numbers. In the past month, they had sent Samsung shares down by about 11%, wiping about $25 billion off its market value, as management issued worrying signs about earnings. The stock closed Tuesday's session up 0.2% after closing at a three-month low on Monday.

The company estimated its sales fell 7.8% to 11.2% from a year ago to a range of 51 trillion won to 53 trillion won. Samsung didn't disclose net profit estimates and final numbers are due later this month.

On average, analysts expect Samsung's operating profit to come in around 8 trillion won for the third quarter, an improvement from the second quarter but a far cry from the record-breaking 10.2 trillion won in operating profit that Samsung logged during the third quarter of 2013.

Memory chips widely used in PCs and other consumer electronics are likely to show continued improvement when the company releases its full earnings at the end of the month, analysts say. But even so, they noted that has less to do with Samsung's fundamental strengths and more with tight supply conditions that have provided a cyclical lift in prices.

Write to Min-Jeong Lee at min-jeong.lee@wsj.com and Jonathan Cheng at jonathan.cheng@wsj.com

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